Saturday, February 1, 2014

Bitcoin for Dummies

There's a lot of talk in my house about Bitcoins these days. Kiddo is absolutely fascinated with them & has even tried his hand at 'mining' them. I have a rudimentary understanding of them, which is slightly better than Hubs understanding, so I attempted to explain them to him after Kiddo got so frustrated the conversation between them had dissolved to insult slinging.

Annnnyway....here is my explanation of Bitcoins for dummies.

In order for it to work you first need a 'bank'. This bank has actual money that is converted into a Bitcoin. You also need a buyer, a seller and a Paypal like system of middlemen for the transaction to go through.

For my explanation, assume a bitcoin is equivalent to a $10 coin made up of 1000 pennies. In reality, because it is cybermoney it is made up of 1000 strings of code (numbers/letters/symbols) called 'hashes'. Its kind of like being handed 1000 promissory notes, each with its own secret code to identify it as a legitimate penny. Individually, these strings are as worthless as pennies, but combined they make up a single $10 note of spendable money. The bank is very careful to not only keep a record of each and every penny of code it has created, but where every one of those pennies are presently located.

Now, you have a person - for my purposes, I'm going to use a character from one of my favorite series - Jane Yellowrock. Jane is shopping on Overstock (which in reality accepts bitcoins as payment) and sees this incredible tunsten steel/silver collar which she absolutely needs to protect her throat from vampire bites. The collar costs $20, but can also be paid for with 2 Bitcoins. It turns out Jane has a very clever computer kid working for her. He uses his computers to help out the bitcoin bank in processing transactions and so Jane has bitcoins to spend.

Jane pays for the collar using 2 bitcoins. What happens next? The middlemen take over.

There is a collective pool of computer geeks or 'miners' have set up their computers to help the bank process transactions - kind of like Paypal plays the middleman between people when they're buying and selling things on ebay.

Now, if you were to walk into a store and try to pay for something with pennies, what happens? The poor person at the counter has to count each and every penny, right? It's the same thing with bitcoins. Each of the 1000 pieces of the bitcoin have to be individually examined to make sure they're real. To look at each of the 1000 takes time. Because the bank doesn't have the time to process each and every hash of code (it would need a giant supercomputer), the middlemen computers step in.

These thousands of computers all over the world are presented with Jane's 2000 strings of code for the 2 bitcoins Jane uses. In other words, each individual string of code is examined by a number of different computers, and those computers determine collectively (based on the information the bank provides) if it is a legitimate code created by the bank and if it actually belongs to Jane (because the bank is fastidious about keeping track). When the collective is finished and has determined that the each and every hash/penny is really a hash/penny, which means the bitcoin is legitimate, the transaction goes through to Overstock and Jane gets her collar.

Now, the bank needs to pay these middlemen for the work they do, because its time & electricity consuming. So, for every transaction they're involved in they get a paid a couple of hashes - in other words a piece of a bitcoin. Sometimes its just one hash, sometimes it's more. Eventually, if the middlemen computers check the hash codes on enough transactions they will have 1000 hashes (or 1000 pennies) and have their own bitcoin, which they can then spend.

Does that make sense now? The reality is bitcoin is the promissory note or payment of the future. Whether it sticks around or not remains to be seen, but we accepted paper money so the likelihood as we go into a more computer oriented society is that bitcoin (or something similar) is here to stay.